Who should lead the global economy?

In terms of global economic leadership, the twentieth century was American, just as the nineteenth century was British and the sixteenth century was Spanish. Some Chinese and Europeans think that they are next. Are they? And should they even want to be?

The most important prerequisite for global economic leadership is size. The bigger an economy, the greater its systemic importance, and the more leverage its political representatives have in international decision-making. The United States is the world’s largest economy, with a gross domestic product (GDP) of roughly $16.7 trillion (€12.3 trillion). The eurozone’s $12.6 trillion (€9.32 trillion) output puts it in second place, and China, with a GDP of around $9 trillion (€6.6 trillion), comes in third. In other words, all three economies are conceivably large enough to serve as global economic leaders.

But an economy’s future prospects are also crucial to its leadership prospects – and serious challenges lie ahead. No one thinks that the eurozone will grow more quickly than the US in the coming years or decades. While China is expected to overtake the US in terms of output by 2020, decades of rigid population-control measures will weaken growth in the longer run, leaving the US economy as the most dynamic of the three.

Another key requirement for global economic leadership is systemic importance in commercial, monetary, and financial terms. Unlike China, a large trade power with underdeveloped monetary and financial capabilities, the eurozone meets the requirement of systemic significance in all three areas.

There is also a less concrete aspect to leadership. Being a true global leader means shaping and connecting the global economic structures within which states and markets operate – something the US has been doing for almost 70 years.

At the 1944 Bretton Woods conference, the US crafted the post-Second World War international monetary and financial order. The basic framework, centred on the US dollar, has survived financial crises, the Soviet Union’s dissolution, and several developing countries’ integration into the world economy.

Today, American leadership in global trade and financial and monetary governance rests on inter-related strengths. The US provides the world’s key international currency, serves as the lynchpin of global demand, establishes trends in financial regulation, and has a central bank that acts as the world’s de facto lender of last resort.

Beyond delivering a global public good, supplying the world’s central currency carries substantial domestic benefits. Because the US can borrow and pay for imports in its own currency, it does not face a hard balance-of-payments constraint. This has allowed it to run large and sustained current-account deficits fairly consistently since the early 1980s.

These deficits raise persistent concerns about the system’s viability, with observers (mostly outside the US) having long predicted its imminent demise. But the system survives, because it is based on a functional trade-off, in which the US uses other countries’ money to act as the main engine of global demand. In fact, export-oriented economies like Germany, Japan, and China owe much of their success to the US’s capacity to absorb a massive share of global exports – and they need to keep paying the US to play this role.

Given this, the big exporters have lately come under intense pressure to ‘correct’ their external surpluses as part of responsible global citizenship. While this has contributed to a sharp contraction of the Chinese and Japanese surpluses, the eurozone’s current-account surplus is growing, with the International Monetary Fund expecting it to reach 2.3% of GDP this year (slightly less than the Chinese surplus).

A global economy led by a surplus country seems more logical, given that creditors usually dictate terms. At the time of the Bretton Woods conference, the US accounted for more than half of the world’s manufactured output. The rest of the world needed dollars that only the US could supply.

Chinese or European leadership would probably look more like the pre-First World War Pax Britannica (during which the United Kingdom supplied capital to the rest of the world in anticipation of its own relative economic decline), with the hegemon supplying funds on a long-term basis. But this scenario presupposes a deep and well-functioning financial system to intermediate the funds – something that China and the eurozone have been unable to achieve.

Despite the 2008 financial crisis, the US remains the undisputed leader in global finance. Indeed, American financial markets boast unparalleled depth, liquidity, and safety, making them magnets for global capital, especially in times of financial distress. This ‘pulling power’, central to US financial dominance, underpins the dollar’s global role, as investors in search of safe, liquid assets pour money into US Treasury securities.

The belief that a common currency and a common capital market would buttress financial institutions and deepen markets was a driving principle behind the eurozone’s formation. But, given the lack of a single debt instrument equivalent to a US Treasury bill, the crisis caused eurozone member states’ public-debt yields to diverge. Bank lending subsequently withdrew to national borders, and the idea of a European capital market disintegrated.

Likewise, in China, the absence of currency convertibility – together with a weak financial supervisory framework, which reflects a broader problem related to poor implementation of the rule of law – is impairing the economy’s prospects for leadership.

Europeans and Chinese should question whether they really want to assume the risks associated with a position at the centre of a large and complex global financial system. Control of the system is the chalice of global leadership; but, for economies that are not adequately prepared for it, what should be an elixir may turn out to be poison.